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Amazon: Next Stop, $2 Trillion?

The exclusive society of companies worth at least $1 trillion added a new member this week, with Amazon.com(NASDAQ:AMZN) joining the ranks of companies surpassing that lofty market cap. It was just over a month ago that Apple (NASDAQ: AAPL) became the first U.S. company to achieve the lofty distinction. It is important to point out that the iPhone maker wasn't the first company to top the 13-figure mark -- that accolade belongs to PetroChina.

Amazon's feat is all the more remarkable, especially considering that its market cap has more than doubled over the past year. Twelve months ago, the e-commerce giant was worth about $477 billion. Even more incredibly, some believe its rapid ascent isn't over, and that the company's value could double again in just a few years.

Image source: Getty Images.

The bullish analyst

Ashim Mehra, an analyst with Baron Capital, believes that Amazon could double in size again -- to $2 trillion -- over the coming three to five years. "When we look at three to five years, we are long-term shareholders, we think this company has the potential to double again in that type of time frame," Mehra said.

In an interview on CNBC's Closing Bell, Mehra cited several potential drivers that could propel Amazon's market cap to unprecedented levels.

It all "ads" up

Advertising is an area that has only recently come into focus for Amazon, and Mehra believes it could result in significant growth. The majority of the company's ad income is a result of sellers paying to promote sponsored products on Amazon's e-commerce site. This gives merchants the ability to more effectively target the demographics likely to purchase their wares. As the size of the company's empire grows, more advertisers are seeking to reach Amazon's expanding list of shoppers.

You might be surprised to know that advertising is already a multibillion-dollar business for Amazon, having exceeded $2 billion in each of the past two quarters. Amazon's recent attention to it is paying off, as advertising revenue has accelerated in recent months, up by 132% and 139% year over year in the first and second quarters of 2018, respectively.

Mehra said: "Advertising, for those of us who have been paying attention over the past few quarters, has really become a big driver. It's an $8 billion run-rate business ... with 70% to 80% incremental margins. If you think about what that could be in three or five years, that could be a $30 billion to $50 billion revenue business with very high margins."

I've looked at clouds from both sides now

The more obvious growth driver is Amazon Web Services (AWS), the company's cloud computing operation. Amazon pioneered the idea of renting space on its servers, and AWS has since become Amazon's most profitable business. "You look at the cloud business ... it's a $25 billion run-rate business, with 30% segment margins," Mehra said.

Image source: Getty Images.

He's not the only one who thinks cloud computing will continue to drive Amazon's growth. Jefferies analyst Brent Thill called AWS "the gold standard for millions of customers," saying that Amazon's cloud remains "the runaway leader in a vast, and still rapidly growing, cloud infrastructure market by a wide margin." He thinks Amazon could even branch into the software-as-a-service market (SaaS), opening up an additional $100 billion market opportunity. Thill is forecasting that AWS could generate $60 billion annually within five years' time, nearly triple its current size.

With year-over-year growth of 49% so far in 2018, AWS still has a significant runway ahead.

The kicker

Mehra pointed to changes in Amazon in recent years as an indicator of where the company could go from here: "The overall profitability of Amazon, when you compare it versus five years ago, if you just looked at the retail business, it's completely different. So the profitability is really inflecting at Amazon over this year and next year."

A compelling illustration of his point is Amazon's operating margins, which have improved across the board recently, compared with the prior year. So far in 2018, Amazon's North American e-commerce margins have jumped from 2.4% to 4.7%, while losses in its international markets lessened, improving margins from -5.3% to -3.7%. AWS also saw improvement with operating margins of over 26% compared to 23% in the comparable period last year.

The company's increasing focus on advertising, ongoing cloud growth, and improving margins make a compelling case. And achieving a $2 trillion market cap within three to five years doesn't seem so far-fetched.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Danny Vena owns shares of Amazon and Apple. The Motley Fool owns shares of and recommends Amazon and Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.

Author

Daniel W. Vena, CPA, CGMA is long-term investor searching for intangibles that provide explosive growth opportunities in his investments. He served on active duty with the US Army and has a Bachelors degree in accounting.
Follow @dannyvena